Wash Sales 101

How the wash sale rule works

A rule that postpones losses if you buy replacement
shares around the same time.

When the value of your stock goes down you get that sinking feeling —
you've lost money. But the tax law doesn't allow that loss until you sell
the stock. In a way that's good, because it means you can control the timing
of your deduction, taking it when the benefit is the greatest.

The problem is, you may have a conflict. You want to deduct
the loss, but you also want to keep the stock because you think
it's going to bounce back. It's tempting to think you can sell
the stock and claim the loss, then buy it back right away. And
that's where the wash sale rule comes in. If you buy replacement
stock shortly after the sale — or shortly before the
sale — you can't deduct your loss.

General Rule

In general you have a wash sale if you sell stock at a loss, and buy
substantially identical securities within 30 days before or after the sale.

Example: On March 31 you sell 100 shares of XYZ at a loss. On
April 10 you buy 100 shares of XYZ. The sale on March 31 is a wash sale.

The wash sale period for any sale at a loss consists of 61 days:
the day of the sale, the 30 days before the sale and the 30 days after the
sale. (These are calendar days, not trading days. Count carefully!) If you
want to claim your loss as a deduction, you need to avoid purchasing the
same stock during the wash sale period. For a sale on March 31, the wash
sale period includes all of March and April.

Contracts and Options

The wash sale rule can apply even if you don't acquire stock. If you
enter into a contract or option to acquire stock, that's enough to make the
wash sale rule apply. Your sale of stock can also be a wash sale if, within
the wash sale period, you sell a put option on the same stock that's "deep
in the money." And you can have a wash sale from selling options at a loss,
too. For more on this subject see Wash Sales and
Options.

Consequences of a Wash Sale

The wash sale rule actually has three consequences:

You are not allowed to claim the loss on your sale.

Your disallowed loss is added to the basis of the replacement
stock.

Your holding period for the replacement stock includes the holding
period of the stock you sold.

The first one is clear enough, but the others may require some
explanation.

Basis Adjustment

The basis adjustment is important: it preserves the benefit of the
disallowed loss. You'll receive that benefit on a future sale of the
replacement stock.

Example: Some time ago you bought 80 shares of XYZ at $50. The
stock has declined to $30, and you sell it to take the loss deduction. But
then you see some good news on XYZ and buy it back for $32, less than 31
days after the sale.

You can't deduct your loss of $20 per share. But you add $20 per
share to the basis of your replacement shares. Those shares have a basis
of $52 per share: the $32 you paid, plus the $20 wash sale adjustment.
In other words, you're treated as if you bought the shares for $52. If
you end up selling them for $55, you'll only report $3 per share of
gain. And if you sell them for $32 (the same price you paid to buy
them), you'll report a loss of $20 per share.

Because of this basis adjustment, a wash sale usually isn't a disaster.
In most cases, it simply means you'll get the same tax benefit at a later
time. If you receive the benefit later in the same year, the wash sale may
have no effect at all on your taxes.

There are times, though, when the wash sale rule can have
truly painful consequences.

If you don't sell the replacement stock in the same year, your
loss will be postponed, possibly to a year when the deduction is of
far less value.

If you die before selling the replacement stock, neither you nor
your heirs will benefit from the basis adjustment.

You can also lose the benefit of the deduction permanently if you
sell stock and arrange to have a related person — or your IRA — buy
replacement stock.

As explained in my book,
Consider Your Options, a wash sale involving shares of stock
acquired through an incentive stock option can be a planning
disaster.

Holding Period

When you make a wash sale, your holding period for the replacement stock
includes the period you held the stock you sold. This rule prevents you from
converting a long-term loss into a short-term loss.

Example: You've held shares of XYZ for years and it's been a
dog. You sell it at a loss but then buy it back within the wash sale
period. When you sell the replacement stock, your gain or loss will be
long-term — no matter how soon you sell it.

In many situations you get more tax savings from a short-term loss than a
long-term loss, so this rule generally works against you.

Additional Rules

There's a lot more to the wash sale rule. We get questions on
our message board about all of the following issues:

You don't have a wash sale, even though you bought identical
shares within the previous 30 days, if the shares you bought aren't
replacement shares.

There are mechanical rules to handle the situation where you don't
buy exactly the same number of shares you sold, or where you bought
and sold multiple lots of shares. See Wash Sale
Mechanics.

If a person who's related to you — or an entity related to you,
such as your IRA — buys replacement property, your loss may be
disallowed under a different rule: you may be treated as if you made
an indirect
sale to a related person.

Losses Only

The wash sale rule only applies to losses. You can't wipe out a gain from
a sale by buying the same stock back within 30 days.

Planning for Wash Sales

What can you safely do to plan around the wash sale rule? No technique is
completely safe. Here are some ideas to consider.

Most obviously, you can sell the stock and wait 31 days before
buying it again. (Check your calendar carefully!) The risk here is
that the stock may rise in price before you can repurchase it.

If you're truly convinced the stock is at rock bottom, you might
consider buying the replacement stock 31 days before the sale. If the
stock happens to go up during that period your gain is doubled, and if
it stays even you can sell the older stock and claim your loss
deduction. But if you're wrong about the stock, a further decline in
value could be painful.

If your stock has a strong tendency to move in tandem with some
other stock, you may be able to reduce your risk of missing a big gain
by purchasing stock in a different company as "replacement" stock.
This is not a wash sale because the stocks are not substantially
identical. Thirty-one days later you can switch back to your original
stock if that is your wish. But there's no guarantee that any two
stocks will move in the same direction, or with the same magnitude.

There's no risk-free way to get around the wash sale rule. But then
again, continuing to hold a stock that has lost value isn't risk-free,
either. In the end it's up to you to evaluate all the risks, and balance
them against the benefit you'll receive if you can claim a deduction for
your loss.